Investments in CEE: switching into the next gear of growth

However, this pro-cyclical upswing alone cannot lift CEE economies to the growth levels that are needed for faster convergence. "The current investment growth dynamics in CEE is around 6%. To restore these countries’ potential GDP growth to the pre-crisis level of 3.7%, the annual growth of investments would need to be boosted to 10-15% in the coming years," says Juraj Kotian, Head of CEE & FI research at Erste Group.

“If the positive economic momentum in CEE is accompanied by real structural reforms, the main pillars of CEE growth and convergence will be domestic investments, a thriving SME sector and EU funds, which should be fully utilized,” concludes Kotian.

Investments in CEE turned a corner in 2014 and are continuously on the up

Positive signs of recovery based on improved business and consumer sentiment, as well as increasing domestic demand have helped investments to pick up in almost all CEE countries. Poland and Hungary already have higher levels of investment versus 2008. Poland is an investment leader in Europe overall, as the Polish economy was spurred by public investments while other countries were coping with fiscal consolidation. In the Czech Republic and Slovakia, investments should climb above pre-crisis levels in 2015/16, as improving business sentiment enhances expansion. Croatia, Slovenia and Romania, however, will need a stronger recovery to restore pre-crisis investment levels.

This time, domestic savings and EU transfers are in the driving seat of financing investments, with FDIs becoming less important

Erste Group analysts find that FDI inflows are going to play a smaller role in financing investments in most CEE countries over the coming years. As the FDI inflow was driven by the privatization process to a great extent, now that this is almost completed in many countries, analysts expect to see lower levels of incoming funds from FDIs. Only Croatia, Serbia and Slovenia still offer some potential, with several privatization projects in the pipeline. However, CEE countries can still benefit from capital accumulation, as the role of local investors becomes more important for the investment development.

SMEs add as much value to CEE economies as they do in Germany and Austria...

With domestic investments now coming to the forefront, the development of the local private sector – especially SMEs – is becoming even more important for employment and productivity growth. SMEs with up to 250 employees account for up to two thirds of the total value added created by business and up to three quarters of total employment across CEE. SMEs in CEE (excluding micro companies) are nearly as labour-intensive and produce almost as much value for the economy as in Germany or Austria. However, micro companies with maximum nine employees, which play a dominant role in CEE, are much more labour-intensive than their larger SME peers.

...but they need a shot in the arm from better access to financing and structural improvements of the business environment

“To give SMEs more impetus, structural improvements in the business environment – such as reducing labor rigidities and costs, increasing transparency of legal environment, simplifying administrative procedures and enhancing the quality of workforce by improving education – are critical. These are especially important for SMEs, as their investments are less pro-cyclical than those of large corporations. In order to scale up and support the growth of local economies, governments need to address the challenges in the business environment, while SMEs and micros in particular must professionalize to get better access to financing,” adds Kotian.

CEE countries have a chance to get one of the biggest slices - EUR 40-60bn - from Juncker’s investment package...

An additional way to revive investments is the EUR 315bn Investment Plan for Europe presented by Jean Claude Juncker, the President of the European Commission. CEE countries have already submitted project proposals worth EUR 282bn to the EC and EIB, based on which the Investment Committee will make its selection. “Since many of the submitted projects are linked to the strongly prioritized energy infrastructure and digital economy, with a high level of readiness for the years 2015-2017, CEE has good chances to get a slice of about EUR 40-60bn or up to one fifth from the whole investment package,” explains Kotian. That would correspond to EUR 3-4bn of loss-absorbing money from EFSI (European Fund for Strategic Investments), with the rest financed by strategic and private financial investors. Many governments might also take the role of strategic investors, with some of them already announcing the intention to provide additional funds on top of the EFSI.

On top of Juncker’s investment package, CEE countries have access to EUR 185bn of EU funds available for CEE for the period 2014-2020. “Overall, there should be enough financing for growth-enhancing investments,” adds Kotian. The main benefit of the Juncker’s Plan is the fact that it entails projects meant to build a more competitive business environment - these should become a political priority with relatively favorable financing.

*Erste Group report ”Investments in CEE: switching to the next gear of growth” covers the following countries: Czech Republic, Slovakia, Romania, Hungary, Croatia Poland and Slovenia.

Juraj Kotian in an interview with Slovak business weekly magazine Trend:

“This or next year, Slovakia should reach the pre-crisis investment levels. In order to return to the average economic growth of before the crisis, investment growth in Slovakia needs to be doubled. The country needs investment growth of 10%, whereas some other CEE countries need even 15%. That is because Slovakia benefited from a higher level of technology as well as a growing number of people in productive age. However, future growth in investments requires even greater involvement by the private sector and SME in particular.”